Economic Scene; Industrial Policy The Korean Way

By Sylvia Nasar

Published: July 12, 1991

Correction Appended

TODAY'S formula for economic success stresses free trade, unfettered markets and minimal governments. Yet the true Horatio Alger story of the third world, South Korea, gave government bureaucrats an unfashionably large role in shaping its economy. Does that mean the reformers have it all wrong? Hardly.

True, Seoul pursued industrial policy before anybody in Washington invented the term. "There really was a Government-business partnership in which Government very much had the upper hand," said Stanley Fischer, an economist at the Massachusetts Institute of Technology. Korea's authoritarian Government threw a protectionist blanket over infant industries, regularly butted into financial markets to control the flow of credit, and, time and again, bullied business into doing what it wanted.

Indeed, one of President Chung Hee Park's first moves in 1961, when Korea's remarkable transformation was just beginning, was to throw some of the country's corrupt capitalists into jail. Larry E. Westphal, an economist at Princeton, said President Park refused to release the executives until they agreed to invest their ill-gotten gains in Korea's new export drive.

Busybody bureaucrats might have strangled Korea's economy, as they did the once-prosperous Argentinas and Ghanas of the world. Instead, Korea, dismissed as an economic basket case by American benefactors in the 1950's, pulled itself out of poverty faster than almost any country ever has -- faster than the United States, Britain or even Japan. In four decades, South Korea's living standards have risen almost tenfold. With an income similar to that of Ghana and India at the time of the Korean War, Korea has since moved into the company of entry-level industrial countries like Czechoslovakia, Portugal and Greece.

The real lesson, World Bank economists say -- and the reason things turned out differently from the way they did in India or Ghana or Argentina -- is that Korea's meddling was "market friendly," "outward oriented" and less pervasive than appears at first glance. Korea's bureaucrats, said Jagdish Bhagwati, an economist at Columbia University, "left a lot to private initiative."

For starters, Korea forced its infant industries to export, thus exposing them to the discipline of market competition. Goodies like cheap credit, tax breaks and outright subsidies were tied to achieving specific targets. Most of the time, when companies failed to thrive even with coddling, they were allowed to fold.

In India, by contrast, the Soviet-style planning bureaucracy created a Kafka-esque system of licensing and import controls that effectively shielded monopolies from domestic as well as foreign rivals. Not surpisingly, India's share of manufacturing in its economy has not grown for more than a decade. Moreover, its inefficient monopolies reaped fat profits at the expense of Indian consumers, who were forced to buy shoddy, high-priced goods. India's big manufacturers enjoyed profit margins of nearly 21 percent in the early 80's, six times the average for Korea's capitalists.

Korea also took a series of steps to guarantee that its actions to protect infant industries did not discourage exports. After the mid-60's, Seoul kept its exchange rate low. Moreover, Korea's exporters generally received exemptions from import tariffs and had access to credit subsidies. In many developing countries, on the other hand, import restrictions drastically distorted the domestic price system in favor of production for the domestic market.

Korea's meddling, pronounced as it was, was light compared with that of many governments. "On a 1 to 10 scale, with the U.S. 1 and Africa 10, Korea is a 3," said Andrei Shleifer, an economist at Harvard. Take the size of government. Government spending as a share of the economy is under 20 percent. Or trade barriers. In Pacific Rim countries, about a fifth of all goods are subject to tariffs or quotas. In India, half to three-fourths of all goods are covered.

Finally, "The Korean Government has always been a Government of do's," Mr. Bhagwati said. "One thing leads to another. The Indian Government, by contrast, has been a Government of 'don't's.' " While Seoul nagged business to meet export targets, New Delhi required some companies to get 200 licenses before they could send a single shipment overseas.

The Indian system "stifled a lot of initiative with enormously detailed controls and restrictions," Mr. Bhagwati said. "We didn't get as much out of our investment as we could have."

Most economists doubt that Korea's industrial policy can easily be duplicated. "Experience indicates that more nations fail than succeed with industrial policies," said Lawrence H. Summers, chief economist at the World Bank.

But Korea's lessons have not been lost on India, which took some tentative steps to open up its economy in the early 80's. Result: India's economy expanded briskly in the last decade while per capita incomes rose three times as fast -- at 3 percent a year -- as in earlier decades.

Correction: July 13, 1991, Saturday The Economic Scene column in Business Day yesterday misidentified Larry E. Westphal. He is an economist at Swarthmore College, in Swarthmore, Pa.